Tuesday, July 24, 2007

Losses from Trade?

Karl Smith has an interesting idea about trade, explained here discursively and with a link to his paper in progress here. The traditional Ricardian theory of gains from trade applies in the case of certainty: those who benefit from liberalized trade will have sufficient benefits that they could (theoretically) compensate the losers and still end up better off, so trade is Kaldor-Hicks efficient ex post. But in a world with uncertainty (and with incomplete insurance markets), liberalization of trade can be Pareto inefficient ex ante. That is, the increased risk to everyone could be such a disadvantage that it outweighs the average expected gains and makes the contemplated liberalization a net disadvantage to everyone involved.

The same could presumably be said for any change that increases uncertainty, which might include technological change. I have a vague, intuitive sense that trade introduces more uncertainty than does technological change, but right now I don’t have any evidence to support that idea.

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49 Comments:

Anonymous Rustyrustbelt said...

Good post.

Drop by the rustbelt and I can show you lots of anecdotal evidence.

Wed Jul 25, 10:15:00 AM EDT  
Blogger Karl Smith said...

Thanks for the pick-up. Suggestions for improvement are always welcomed

Wed Jul 25, 02:16:00 PM EDT  
Anonymous Constance said...

That all makes a lot of sense when the agents have independent utility functions.
Nevertheless I do agree: you have to weigh your gains and your losses. And uncertainty makes dealing more difficult - you don't want to give it all up only to find yourself ditched. It clearly would be optimal if some or all of the uncertainty could be resolved before a firm deal is struck.
Agents really need to talk things over. Mutual respect and understanding will certainly go a long way in resolving uncertainties.
I'm generally optimistic(except regarding humankind's ability to deal with global warming, which is of course not trivial).

Wed Jul 25, 11:48:00 PM EDT  
Blogger reason said...

Wow!
Someone has noticed uncertainty (and presumably costs of adjustment). Next they will look at second best theory and the danger of financial manipulation and all that concensus on trade will get weak at the knees.

Fri Jul 27, 06:26:00 AM EDT  
Anonymous bad poker player said...

Gotta run again, so I doubt I will adequately understand reason and may mess things up again. An overly forceful expression of preferences may be misconscrued as manipulation. Someone has to express preferences. I suppose one should choose an appropriate forum, but one may not have a choice of forum and just use what they have been allowed.
Bottom line: that someone is fully committed and is looking for the same.

Sat Jul 28, 02:36:00 PM EDT  
Anonymous Hope said...

Waiting with great anticipation for the day when traders meet face-to-face and uncertainty melts away.

Sun Jul 29, 08:49:00 PM EDT  
Anonymous freggy lives said...

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Sun Jul 29, 11:02:00 PM EDT  
Blogger reason said...

Bad Poker Player...
I'm pretty sure you misunderstood me. (Maybe I should leave it at that, it introduces just the right degree of uncertainty - but shucks I'll clarify).

One of the risks is financial manipulation (that real exchange get painfully out of whack so price signals are all f*!@d up).

There is also the little issue of it being harder to invest when you don't know where your competition is coming from.

I've always been an arms length free trade man - if you like "you can all come and play, same rules for every one, but you have to pay for the privilege".

Tue Jul 31, 10:24:00 AM EDT  
Anonymous bad poker player said...

Reason: it is truly unfortunate that price signals are all messed up.
Traders perceiving reticence can get confused as to what the real issues are and flail all over the place trying to come up with the 'right' price, surely making unintended mistakes, but also probably thoughtless ones.
Trading can be difficult when it really should be so easy.

Tue Jul 31, 05:01:00 PM EDT  
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Blogger Laurent GUERBY said...

I wrote in April 2006 a blog entry about Ricardo (in french) where I mentionned about the "gains from trade":

"""Un des aspects non abordés sur wikipédia ou dans l'article Krugman est qu'un système totalement spécialisé est nécessairement moins tolérant aux risques, et les risques pris ont bien sur un prix, ce qui est une autre limite à prendre en compte."""

Translation: "One of the point not touched upon on wikipedia or in Krugman article is that a specialized system (where all countries produce according their optimal comparative advantage) is less tolerant to risk, and risk of course have a price: this is another limit to take into account".

This is not exactly the same as Karl Smith a priori distributional risks based on uncertainty, but it's certainly another kind of risk that should be studied and I couldn't find any publication about it.

Sun Aug 05, 04:43:00 AM EDT  
Blogger reason said...

Laurent Guerby,
I'm sure you're correct (it corresponds to my intuition), but have you a proof (or at least a plausible argument) for why your proposition that "a specialized system (where all countries produce according their optimal comparative advantage) is less tolerant to risk" is true.

Tue Aug 07, 09:17:00 AM EDT  
Anonymous constance said...

Yes, I wonder about that too. Specialization is risky if production is so centralized that a shock could wipe out the entire crop, leaving everyone hungry. But for most commodities, that would not be the case, and specialization and trade does then provide some crop insurance.
On the other hand, Laurent is probably talking national security risk, and there probably would not be a lot of empirical evidence on that one, but I suppose there must be some.

Tue Aug 07, 10:52:00 PM EDT  
Blogger Karl Smith said...


This is not exactly the same as Karl Smith a priori distributional risks based on uncertainty, but it's certainly another kind of risk that should be studied and I couldn't find any publication about it.


Batra and Russell AER, 74 discuss terms of trade risk, which is similar to what you bring up.

In fact, I believe upon quick reading some people assume that my argument on distributional risk is the same as theirs. However, their argument is about systemic risk to consumers and producers where mine focuses specifically on idiosyncratic risk.

Wed Aug 08, 10:36:00 AM EDT  
Blogger Laurent GUERBY said...

Karl, thanks for you reference, I assume this is: Gains from Trade Under Uncertainty, not downloadable freely unfortunately.

reason, each time the news mention a local disruption having a global effect you have another proof :). Latest example (within country, but frontiers can be arbitrary :) is the japanese car industry being totally stuck (producing zero cars) for a few days because only one company is producing a particular part and this particular company plant was hit hard by the earthquake.

Another example was for the computer memory market when a quake disrupted operation near where most if not all computer memory plants are located. There was a big spike in prices, big spike = quantitative risk.

Wed Aug 08, 03:12:00 PM EDT  
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